Wednesday, February 11, 2009

Anticipating Volume for the Coming Trading Day

I notice that the Twitter Trader feature logged its 5000th posting today. I hope today's morning "tweets" were helpful, as it became relatively clear early in the trading session that we were seeing range bound conditions. (See the Twitter page for a complete set of tweets, as well as the link for free subscription via RSS). As I emphasized in the recent posting on range trading, identifying such sessions early is key to formulating a trading strategy for the day.

One of the important implications of a range day is that we're less likely to hit the R1/R2/R3 and S1/S2/S3 targets that I post each morning before the open. Instead, we're more likely to oscillate in a relatively low volatility band around the day's volume-weighted average price. Tempering one's expectations is helpful to one's psyche, as well as one's trading.

But is it possible to anticipate likely volatility and opportunity *before* the trading day begins? In a recent post, I stressed the importance of the overnight trading range. Perhaps we can look to the activity of the market before the open as a way of anticipating activity early in the morning session.

To examine this issue, I went back to early January (N = 26 trading days) and looked at the volume in the ES contract between 17:00 CT and 8:30 CT to see how it has correlated with volume from 8:30 CT to 10:30 CT. Interestingly, busier pre-opening sessions have been associated with busier early morning sessions, with a correlation of .65. To put that into perspective, over 40% of the variance in early morning volume can be explained by volume prior to the market open. Since we know that early morning volume correlates .70 with early morning volatility (size of trading range), knowing the relative volume of the pre-opening hours provides a bit of a heads up for morning participation and possible volatility.

For number fanatics out there, the median volume for the pre-opening hours in the ES contract has been 203,772 contracts, with a standard deviation of about 57,000 contracts. Because pre-opening volume represents participation triggered by overseas events and pre-opening economic reports, it makes sense that conditions favorable to activity before the open will also lead to activity after the bell. I'll be watching this indicator going forward as part of my efforts to proactively identify day structure and opportunity..

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), and The Daily Trading Coach (Wiley, 2009) with an interest in using historical patterns in markets to find a trading edge. I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab).